Business Structures: Limited Liability Company
A Limited Liability Company (LLC) combines elements of a partnership/sole proprietorship with elements of a corporation. With an LLC, your personal assets are protected (like in a corporation), but your taxes are pretty simple and you have more operational flexibility (like in a partnership or sole proprietorship).
An LLC can be owned by a single person, multiple people, or even a corporation. The owners are typically called “members”.
How to Form an LLC
1. Choose your business’s name.
2. File your Articles of Organization with your local Secretary of State’s office and pay the filing fee.
Your Articles of Organization is a pretty simple document to put together. It includes the business’s name and address, as well as the names and addresses of the LLC’s members.
It will also designate the registered agent, which is the person responsible for receiving any legal documents for the LLC. The registered agent can be one of the members, as long as they’re in the same state where the company is established.
3. Create an Operating Agreement.
Some states require you to file an Operating Agreement. Even if your state doesn’t require one, it’s a good idea to create one. Similar to a Partnership Agreement, it structures your company’s finances, details how profits and losses will be allocated, and defines each member’s rights and responsibilities.
4. Obtain the proper business licenses and permits.
5. Publish a statement announcing that you’re forming an LLC, if your state requires it.
If you’re establishing your LLC in Arizona, Nebraska, or New York, you’ll have to publish a notice in the newspaper announcing your LLC formation.
In Arizona, the Arizona Corporation Commission (AZCC) will send you a Notice of Publication after you’ve formed your LLC. Then, you must publish the notice in a newspaper for 3 consecutive runs (typically, 1 day per week for 3 weeks). After the notice has been run, the newspaper will send you an Affidavit of Publication, which you’ll submit to the AZCC.
In Nebraska, you must run a Notice of Organization in a newspaper near you (typically, the county where your LLC is established) for 3 weeks. After the ads have run, the newspaper will send you an Affidavit of Publication. Send a copy to the Nebraska Secretary of State.
In New York, you must publish a notice about your formation in 2 newspapers, which have to be approved by the County Clerk in the county of your LLC’s office. One newspaper has to have a daily circulation, while the other has to have a weekly circulation. The ads must run for 6 consecutive weeks. After the ads have run, the newspapers will send you Affidavits of Publication. Submit both affidavits, a Certificate of Publication, and a $50 filing fee within 120 days of forming your company.
Tax Obligations
An LLC is an entity created by state statute. Depending on your elections, the company can be taxed as a sole proprietorship, partnership, or corporation.
Unless you choose otherwise, a single-member LLC will be taxed as a sole proprietorship, and a multi-member LLC will be taxed as a partnership. So, the LLC will not be taxed separately from its members. Instead, the profits and losses will “pass through” to the members, who will report their portion of the profits and losses on their personal tax return.
A Single-Member LLC
If your company is a single-member, LLC, then the IRS considers you a disregarded entity. So, you’ll be taxed as a sole proprietorship and report your profits and losses on a Schedule C, Profit or Loss from Business.
A Multi-Member LLC
If your company is a multi-member LLC, you’ll be taxed as a partnership. So, you’ll pay taxes based on your share of the company. The LLC will file Form 1065, U.S. Return of Partnership Income and prepare a Schedule K-1, Partner’s Share of Income, Deductions, Credits, etc.
What if I Want to Be Treated Like a Corporation?
If you want your LLC to be taxed as a corporation, you’ll file Form 8832, Entity Classification Election.
You may choose to be treated like a corporation if your total taxable income is high, and you want the profits to be taxed at the lower corporate tax rate. Be careful, though, because you might end up being taxed twice on that profit (once as a corporation, then again on your dividends).
You Can Also Be Treated like an S Corporation
You can also elect an S Corporation (S Corp) status, if you meet the eligibility requirements. An S Corp is also a pass-through entity, like a partnership and sole proprietorship.
As an S Corp, you would be able to avoid the double taxation, and you (as the owner) will be treated as an employee, too. The LLC will be able to withhold payroll taxes from your income, so you’ll avoid the self-employment tax.
You’ll elect to be treated as an S Corp by filing Form 2553, Election by a Small Business Corporation. You must make the election no more than 2 months and 15 days after the beginning of the tax year.
If you’re considering being treated like a corporation or an S Corp, we recommend speaking to your legal counsel, first.
Is an LLC Right for My Business?
Pros of Forming an LLC
There are several benefits of forming your company as an LLC:
- Members are protected from personal liability, and their personal assets are usually protected, if the business goes into debt or gets sued.
- There is less paperwork involved when starting an LLC, versus a corporation.
- It’s typically cheaper to form an LLC than a corporation.
- Members can decide what percentage of profits and losses each member receives.
- Unless you elect otherwise, you won’t file a corporate tax return, since an LLC is a pass-through entity.
Cons of Forming an LLC
There are also some disadvantages of forming an LLC to consider:
- If a member leaves, the business is dissolved and the members are responsible for fulfilling any remaining legal and business obligations.
- Members are considered self-employed, so they must pay self-employment taxes. The entire net income of the business is subject to self-employment tax.
- You cannot issue shares of stock, making it harder to attract investors.
